Bankers set asset risk endogenously, reflecting actual leverage. Even when bankers have superior information, contingent capital introduces a chance of equity dilution which reduces risk-shifting by deleveraging in low value states. The optimal amount of contingent capital avoids too frequent and large dilution, which reduces the banker’s stake and encourages risk taking. We show that contingent capital bonds may be less risky than conventional debt as they contain risk endogenously, and they may dominate voluntary conversion bonds as in Green (1984). The amount of contingent capital which achieves the same risk incentives as equity depends on the informativeness of the conversion trigger.